How should we define money? (warning: this post is pure semantics)

E. Barandiaran writes in the comments:

Tyler, I hope that tomorrow (7/14) you read this comment about Arnold Kling's challenge to BC: define money that meets two requirements. Please tell AK that his two requirements were the same that Milton F. argued for the QT of M to make sense –but as anyone familiar with the history of Milton's version knows, he failed miserably. I'm still waiting your definition of money.

Arnold Kling writes:

So my challenge for Bryan (and for the rest of the profession, because I am the one who is out on a limb on this) is to come up with a definition of money that satisfies two criteria. First, your monetary aggregate is correlated with nominal GDP in a reliable way (with "reliable" including that if you were to target it, the relationship would not fall apart). Second, the Fed controls that monetary aggregate reasonably closely.

No definition of money fits Arnold's challenge (though Bryan argues for the monetary base) and I'm not going to offer a single definition of money, period.  I see money first as a medium of account and then as an option on purchasing goods and services.  As an option, "money" is more like "credit cards" than many economists might find comfortable, but so be it.  No single number very well summarizes the quantity or outstanding value of the money supply, properly understood to include the option value of lines of credit but also the option value of currency and bank reserves.  (Bill Barnett promotes "divisia indices," which I view as a nice try to a hard-to-solve problem.)

That said, a large, exogenous shift in the money supply will raise the general level of prices.  There is overwhelming evidence for that proposition (check out my macro Principles text with Alex, for one good chart, or visit Zimbabwe).  If some mix of currency, bank reserves, and useful lines of credit go up, prices will go up too, in very rough proportion, no matter what the exact measure of the money supply should be.

A lot of the better criticisms of the quantity theory play off of whether "money" is exogenous in the first place.  Many of the points of these critics are well-taken, but still a properly specified exogenous boost in the money supply will bring the traditional quantity theory result.  You just don't have to see that exogenous shift as the only relevant scenario for all real world monetary economics.

I see this post as "a lot of words."  I'm not saying much, I am just trying to limit how much other people's words confuse you.

On the quantity theory, I recommend reading and studying Arthur Marget's A Theory of Prices, especially volume II.  Marget was a penetrating thinker who understood his chosen topics better than anyone else and who was very good at pulling out the deep truths in apparently simple propositions.  I think of him as the Scott Sumner of his day, minus a blog.


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